New Bond Offerings Soaring Amid Political Drama

Corporations rushing to issue new debt before interest rates on T-bonds rise significantly

Last week, the S&P 500 logged its third straight weekly decline, and stocks plunged Monday on European debt worries, but I believe this is merely a “pause that refreshes” before the next earnings reporting season begins in July. There is good reason to believe that second-quarter corporate earnings will continue delivering positive surprises, but the big news last week reads more like a gossip column, involving dissension at the International Monetary Fund (IMF) and the Fed.

Despite the fact that former IMF Director Dominique Strauss-Kahn dominated the gossip pages last week, his sudden departure from the IMF seemed to undermine the euro a bit, since the IMF was in the midst of drafting a controversial plan to help Greece restructure its debt. Soaring yields on Greek debt have been crippling that nation from paying down its original European Union/IMF loan. Last Friday, Fitch Ratings downgraded Greece three notches to B+, meaning that Greek bonds have gone from junk to smelly junk!

Meanwhile, the Federal Reserve Board is fighting an ongoing civil war between its hawks and doves. On Wednesday, the minutes of the last Federal Open Market Committee (FOMC) meeting revealed that the FOMC is now composed of five “doves” (whom President Obama named to the Fed). These doves do not want interest rates to rise as long as unemployment remains high. On the other side, five hawks advocate raising rates fairly soon. In effect, the “independent” Fed has been invaded by White House doves! When traders realize that the Fed is becoming a political pawn, I expect that the U.S. dollar will resume its decline.

The doves at the Fed have been sopping up most of the massive new Treasury bond debt. Mohamed El-Erian, CEO of the fixed-income giant PIMCO, told Maria Bartiromo that the Fed has been buying about 70% of new Treasury debt at recent Treasury auctions. He predicted that when the Fed withdraws its support, Treasury securities will be at risk. In effect, the U.S. government is playing a “shell game” by buying its own debt. No wonder PIMCO’s Bill Gross, manager of the largest bond fund in the world, recently increased his short position in U.S. Treasury securities! Bloomberg reported that Gross is upping his allocation in corporate bonds. Apparently, China is following PIMCO’s lead, since China trimmed its holdings of U.S. Treasury debt in April by $9.2 billion to $1.14 trillion, the fifth straight monthly decline.

China is spending some of its dollars on gold. The Wall Street Journal reported on Friday that Chinese buyers overtook India last quarter to become the world’s biggest gold investor. The World Gold Council said in its quarterly report that China’s investment demand for gold more than doubled to 90.9 metric tons last quarter versus India’s 85.6 tons. As inflation fears continue to rise in China, more middle-class Chinese savers and investors are turning to gold. The marketing of gold investments in China has also increased in recent months as the Chinese become increasingly interested in protecting themselves against inflation.

The most somber economic news last week was that the World Bank said that it expects the U.S. dollar to lose its dominant currency status by 2025 as the euro as the Chinese yuan emerge as equal currencies in a new “multi-currency” monetary system. The World Bank also said that the BRIIC countries (i.e., Brazil, Russia, India, Indonesia and China) will account for more than 50% of global growth in the next 14 years. Emerging economies will grow 4.7% a year, the World Bank says, versus 2.3% for the advanced economies.

Speaking of the dollar, we are fast approaching another debt ceiling and another potential government shutdown. Specifically, Treasury Secretary Tim Geithner said on Tuesday, “Yesterday, we reached the debt limit, and because Congress has not acted, we were forced to deploy a series of extraordinary measures to prevent default,” like suspending new investments in federal retirement and disability funds to avoid hitting the debt ceiling. It’s hard to see the dollar rallying with these kinds of big debt problems.

QE2 ends in less than three weeks. The fear of what will happen when the Fed winds down quantitative easing on June 11 is causing some unforeseen consequences. Last week, The Wall Street Journal reported that U.S. corporations are rushing to issue new corporate debt before interest rates on Treasury bonds start to rise significantly. So far this year, corporations have issued up to $20 billion per week of new debt, but new bond offerings soared last week, as Alabama Power, Cintas Corp. (NASDAQ: CTAS), The Walt Disney Company (NYSE: DIS), Duke Energy (NYSE: DUK), Google (NASDAQ: GOOG), Great Plains Energy (NYSE: GPX), Johnson & Johnson (NYSE: JNJ), Norfolk Southern Corp. (NYSE: NSC), Ryder System (NYSE: R), Southern Company (NYSE: SO) and Texas Instruments (NYSE: TXN), among others, rushed to borrow at cheap rates, just in case long-term rates soar next month.

Ironically, this onslaught of new bonds helps to put a floor under stock prices, since these companies are mostly issuing new corporate bonds in order to:

1. Refinance their outstanding bond debt at lower interest rates;
2. Buy back their own stock; or
3. Buy their competitors.

Each action is shareholder-friendly. In other words, a healthy corporate bond market is boosting earnings per share and fueling merger mania. When Chief Financial Officers (CFOs) can borrow at 3% to 5% and boost their Return on Equity (ROE) 12%, they will continue to issue new corporate bonds and raise earnings per share in upcoming quarters!

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